US ratings, hot potatoes & India story

Market sentiment is one thing, real problems quite another. So, when leaders of the world — the very rich G7, the upcoming G20 or any other nation — think about what to do when the world's most powerful economy loses its Triple-A rating (extremely strong capacity to meet financial commitments), they need to grapple with three hot potatoes.

India, in particular.

The first is finance. When the US falls a notch to AA+ (very strong capacity to meet financial commitments, with the '+' indicating a relatively better score than other AA), it will ideally have to pay a higher interest rate on its sovereign paper.

As a result, other countries too will have to pay a higher return on their sovereign debt as well. This has an impact on corporate borrowing, and companies too will have to bear a higher cost when selling bonds. The US downgrade is not going to hurt India very much — the Reserve Bank of India has already raised policy rates to levels that are far higher its global rating. And the reason is domestic: inflation.

Which brings us to the second hot potato — economics. While most of the developed world is fighting a contraction or recession and a strange phenomenon where close-to-zero interest rates are not enough for companies to borrow, the case in India is the reverse.

Excessive economic growth — the second-highest after China — has unleashed a dynamism and cash in the system without the accompanying increase in supply of goods and services. The result: a high inflation rate.

This is a very nice "problem" to have. Because of high economic growth, a country attracts capital from across the world. This capital, when invested in businesses or even real estate, creates jobs and ensures the accompanying prosperity through secondary and tertiary employment. But sudden growth spurts need equally strong and immediate solutions for managing shortages in food, transport, goods and services. This is particularly important for countries like India that is running on domestic consumption boom — driven by the growth — and not merely exports like China.

But to do that, we come to the third hot potato — politics. While the Obama administration is under pressure of being "less stable, less effective and less predictable than what we previously believed", according to S&P, and as a result is now in the same bracket as China and Japan (both AA-) and Spain, Kuwait and Slovenia (AA), bad politics is affecting India in a different way.

India needs to take advantage of the uncertainty that has infected the globe since October 2008 and attract as much capital into the country as possible by opening up banking, retail, insurance, pensions, mining and so on. Instead, the government has been frozen into political submission by one scam after another, leading to a perception that we're going nowhere. This is clearly an exaggeration.

Instead of wondering about the Sensex and pandering to markets, the Indian leadership needs to pull its political act together and get moving on reforms. The world is crumbling around us, and we will be hurt, of course. But if we focus on job creation, build real economies and serve real people, markets will come around.